Report of the Review Group on State Assets and Liabilities

8/7/2019 Report of the Review Group on State Assets and Liabilities

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Report of the

Review Group on State Assets and Liabilities

April 2011


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Table of Contents

Section 1: Introduction and Summary ................................................................................ 1Section 2: Asset Sales and the Policy Context.................................................................... 5Section 3: Market Design and Regulatory Reform........................................................... 13Section 4: The Commercial State Companies in Aggregate............................................. 20Section 5: State Energy Companies and the Policy Framework....................................... 32Section 6: Electricity Supply Board (ESB)....................................................................... 38Section 7: EirGrid and the High-Voltage Electricity Transmission Grid......................... 47Section 8: Bord Gis ireann and Gas Industry Structure................................................ 51Section 9: Seaports and Port Industry Structure ............................................................... 58Section 10: Bord na Mna ................................................................................................ 64

Section 11: Coillte Teoranta ............................................................................................. 70Section 12: State Airports and Aer Lingus ....................................................................... 78Section 13: The Irish Aviation Authority ........................................................................ 88Section 14: Coras Iompair irean (CIE)........................................................................... 94Section 15: Public Service Broadcasters (RT and TG4) .............................................. 100Section 16: An Post and the Postal Market..................................................................... 106Section 17: Irish National Stud, Horse Racing Ireland, Bord na gCon ......................... 113Section 18: Asset Management in Certain non-Commercial Sectors............................. 119Section 19: Intangible Assets.......................................................................................... 122Section 20: Conclusions and Recommendations ............................................................ 128Appendix 1 State Commercial Companies: Employee Remuneration........................ 135

Appendix 2 International Experiences with Forest Privatisation ................................ 137Appendix 3 ESB Financial Data .................................................................................. 140Appendix 4 EirGrid Financial Data ............................................................................. 143Appendix 5 Bord Gis ireann Financial Data............................................................ 145Appendix 6 Dublin Port Financial Data....................................................................... 148Appendix 7 Bord na Mna Financial Data .................................................................. 152Appendix 8 Coillte Financial Data .............................................................................. 155Appendix 9 Dublin Airport Authority Financial Data................................................. 158Appendix 10 Irish Aviation Authority Financial Data ................................................ 161Appendix 11 CIE Financial Data................................................................................. 164Appendix 12 RT Financial Data................................................................................ 168

Appendix 13 An Post Financial Data........................................................................... 172Appendix 14 Bodies and Individuals that Made Submissions to the Review Group .. 176References....................................................................................................................... 178


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Section1:IntroductionandSummary

It is not sustainable for the state to continue to borrow at current levels and all avenues forreducing expenditure and raising additional revenues must be explored. Opportunities tode-leverage the state balance sheet through asset realisations must also be examined.

It is in this context that the Minister for Finance established the Review Group on StateAssets and Liabilities in July 2010 to advise on how commercial state assets can be betterdeployed or disposed of to support economic recovery.

1.1. Membership and Terms of Reference of the Review Group

The Minister appointed Mr. Colm McCarthy, School of Economics, University CollegeDublin as member and chair of the Review Group; the other members were Mr. DonalMcNally, Second Secretary, Department of Finance, and Prof. Alan Matthews, Departmentof Economics, Trinity College, Dublin. The Group was supported by a Secretariat providedby the Department of Finance.

The Review Group was given the following terms of reference:

1. To consider the potential for asset disposals in the public sector, includingcommercial state bodies, in view of the indebtedness of the state;

2. To draw up a list of possible asset disposals;3. To assess how the use and disposition of such assets can best help restore

growth and contribute to national investment priorities; and4. To review where appropriate, relevant investment and financing plans,

commercial practices and regulatory requirements affecting the use of suchassets in the national interest.

The Group began its work at end July, 2010.

The Group invited all Government Departments and commercial state bodies to makeformal submissions and it also advertised generally for submissions from interested parties.Over 45 submissions were received. Between September 2010 and February 2011, theGroup met delegations from all of the main commercial state bodies, the appropriateregulatory authorities and individual economic and regulatory experts in the various sectorsof the economy. The Group wishes to acknowledge the considerable co-operation it has

received.1 The Group engaged Mr. Joe Burnell to assist with financial analysis and wishesto record its appreciation of his contribution and those of Mr. Michael Perkins and Mr.Ronan Gallagher, who acted as the secretariat to the Group.

The Review Groups deliberations were focused primarily on commercial state bodies, butit also examined certain of the states intangible assets to determine whether they areefficiently allocated and priced. In framing its recommendations, the Group paid particularattention to questions of market design and the regulatory reforms necessary to underpincompetition and appropriate levels of investment, especially in those sectors where there

1 A list of the organisations and individuals who made submissions to the Group and/or who met with the

Group is provided at Appendix 14.


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are natural monopolies subject to statutory regulation. The recommendations are intendedto enhance the competitiveness of the sectors of the economy where state bodies are active,even in cases where the Group has not recommended that the state divest its interest at thistime.

1.2. Assets Reviewed

A list of the assets to be reviewed was attached to the terms of reference, as follows:

(i) Commercial State BodiesDublin Airport Authority

Dublin, Cork and otherport companies

An Post

Irish Aviation Authority Bord Na gCon RTHorse Racing Ireland TG4

CIE (including Dublin Bus,Irish Rail, Bus Eireann) Irish National StudCompany

National Oil ReservesAgency

ESB Bord Na Mna Bord Gis ireannEirGrid Coillte

(ii) Intangible Assets

These include, inter alia, radio spectrum allocated for broadcasting andtelecommunications; carbon emissions permits; and mineral, hydrocarbon andother licences issued by the state.

1.3. Exclusions from consideration by the Group

VHI: The VHI was excluded from the Review Group's terms of reference because theGovernment had already initiated a separate process that addresses both the sale of the VHIand the wider complexities involved in the private health insurance market.

The National Oil Reserves Agency (NORA): NORA featured in the list of commercialstate bodies attached to the Review Groups terms of reference, agreed by Government inJune 2010. As per the provisions of the National Oil Reserves Agency Act, 2007, NORA isa non-commercial state agency whose function is to manage the states strategic stocks ofoil. Although substantial, the strategic stock cannot realistically be run down because

Ireland is obliged, as a member of the EU and the International Energy Agency (IEA), tohold stocks of at least 90 days of oil for use in the event of major oil shortages nationally orinternationally. On this basis the Review Group does not propose to make anyrecommendations in regard to NORA.

NAMA: The assets held on behalf of the state by the National Asset Management Agencyas part of the Governments programme of remediation for the banking sector are outsidethe terms of reference of the Review Group.


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Banks: The government has acquired substantial ownership stakes in certain banks as aresult of the rescue and re-capitalisation process. These stakes may be disposed of in duecourse but the Group feels that it is too early to consider concrete disposal options.

1.4. Summary of the Groups Recommendations

The recommendations are presented throughout the text and gathered for ease of referencein Chapter 20. They can be summarised as follows:

We are recommending that there should be a planned programme of asset sales to reducethe states very high level of indebtedness.

We are not recommending an accelerated sale process. This would inhibit attainment ofvalue and in many cases would not be prudent or even possible given the requirement forrevised regulatory procedures and complex legislation.

We are not putting valuations on individual state assets in this report. These depend onmany factors and ultimately on what a buyer will pay. The net asset value of commercialcompany assets whose disposal is recommended is about 5 billion, but net asset value isno more than a rough guide to what might be realisable.

We are recommending restructuring of state companies and strengthened regulatoryarrangements as preludes to possible sale, but also to enhance the competitiveness of theeconomy even if assets are not sold.

We are not recommending that core transmission assets in gas and electricity be sold to

private interests in the immediate future. Such assets have been successfully privatised insome countries but we believe that disposal in current Irish circumstances involves risksand that consideration of this option should be deferred.

We are recommending changes in the governance of state bodies while they remain inpublic ownership to enhance efficiency and performance. We also propose a review ofregulatory arrangements and a new structure for the oversight of regulatory agencies.

We are not proposing that all assets be disposed of. In the case of land-based assets inparticular, we propose that the state sell the rights to reap the produce of the land but notthe land itself.

We are proposing that intangible assets (rights, licences, options, leases etc.) be treated inexactly the same way as tangible assets. They should invariably be sold to the highestbidder.

The Groups appointment pre-dates the resort, in November 2010, to official financingfrom the International Monetary Fund and the EU institutions. The Memorandum ofUnderstanding dated 28 November 2010 mentions the Groups consideration of theseissues and enjoins the Irish authorities to consult with the IMF/EU later this year. It doesnot specify any target for an asset disposal programme.


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We are proposing a planned, prudent approach designed to secure maximum value toreduce the debt burden and to meet and protect the public interest, decisions on which are amatter for the Government and the Oireachtas.


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Section2:AssetSalesandthePolicyContext

Economic recovery, including in particular the generation of sufficient economic growth to

expand employment and to generate government revenue to ease debt service burdens,must be the central concern of economic policy. The realisation of proceeds from state assetdisposals can assist the adjustment process - through reducing the debt burden - but suchassets can also be used to support economic recovery through enhancing productiveefficiency and competitiveness. The Group believes that it is inadvisable to focus solely onshort-term revenue maximisation through, for example, conferring excessive market poweron entities to be disposed of, and that conflict between revenue realisation and thepromotion of longer-tern economic growth should be clearly resolved in favour of thelatter.

2.1Economic and Fiscal Outlook

This policy analysis of state asset utilisation is taking place in the context of a deepeconomic and fiscal crisis. GDP in 2010 was 11.8% below its 2007 level in real terms andGNP 15.6% below that benchmark. Employment has fallen by about 15% from its peak inQuarter 3 of 2007 and the seasonally adjusted unemployment rate has risen from 4.5% to14.7% over the period.

Chart 2.1 shows the trend in real GNP expected when the National Development Plan2006-2013 was prepared versus what has actually occurred and what is now projected. Realeconomic activity in the middle of the current decade could be 40% below the projectionsmade in the NDP, launched in January 2007. Investment plans made at that time need to bere-considered, where this has not already been done, in the light of the substantial reductionin pressure on infrastructure capacity which has resulted.

A downturn of this magnitude is without precedent here and has few parallels at aninternational level. This is after average annual growth rates of 7.3% and 6.6% in real GDPand GNP respectively between 1994 and 2007 and an increase of over 900,000 in the

Chart 2.1: GNP Forecasts: Comparison between National Development Plan 2006 and Budget 2011

80000

100000

120000

140000

160000

180000

200000

220000

1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

Real GNPm

National Development Plan 2006 Actual Outturn and Budget Forecasts

The NDP forecastthat real GNP would

be 42% higher in2013 than is now

expected


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numbers at work. The crisis has had a severe impact on the public finances. Tax receipts in2010 were around 33% lower than in 2007 despite increases in rates of taxation. At thesame time, net current spending has continued to rise because of the sharp rise inunemployment and a mounting debt interest burden. The public finances have deteriorated

rapidly and a structural gap has opened up between spending and revenue which will notreadily be closed.

2.2 Budgetary Adjustment

The gap between budgetary receipts and spending came to almost 19 billion in 2010. TheGovernment has already taken significant actions to prevent the gap from widening further.Table 2.1 shows adjustments to expenditure and revenue amounting to a cumulative 20.8billion already implemented between July 2008 and Budget 2011 in pursuit of thisobjective. Despite the scale of the adjustment, a very large and unsustainable gap remainsbetween spending and revenue which is filled by borrowing.

Table 2.1: Budgetary Adjustments since mid-2008 Planned Budgetary Impact

July 2008Expenditure adjustments

1.0

Budget 2009 (October 2008)Revenue raising measures

2.0

February 2009Expenditure adjustments

2.1

Supplementary Budget (April 2009)Revenue-raising & expenditure-reducing measures

5.4

Budget 2010 (December 2009)

Expenditure-reducing & minor revenue-raising measures

4.3

Budget 2011 (December 2010)Expenditure-reducing & revenue-raising measures

6.0

Total 20.8bnSource: National Recovery Plan 2011-2014 and Budget 2011, Department of Finance (2010).

The burden of debt service is absorbing a rapidly increasing proportion of tax revenue, evenassuming no upward pressure on interest rates. Moving towards a balanced budget istherefore a prerequisite for re-entry to the bond market. A strategy to address this was setout in the National Recovery Plan (published on 24th November 2010) and implemented for2011 in the Budget published on 7 December 2010.

2.3 Budget Outlook

Achievement of the budget targets set in the National Recovery Plan 2011-2014 ispredicated on implementing the expenditure and taxation adjustments set out in the Plan.To the extent that asset sales can provide revenue and reduce the level of debt and debtinterest payments, they can contribute to reducing the burden of spending cuts and taxincreases otherwise necessary and the pain to be suffered by all sections of the community.Asset sales must be viewed in this light and in the light of very limited policy alternatives.


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2.4 De-Leveraging, Balance-sheet Management and the EU/IMF Programme

The public finance and banking crises culminated, during November 2010, in an inabilityon the part of both government and the guaranteed banks to access international credit

markets on normal terms. The state had chosen to withdraw from the bond market inOctober in the face of deteriorating interest rate spreads and the banks were experiencingresource outflows and continuing heavy reliance on liquidity provision from the EuropeanCentral Bank and the Irish Central Bank. The outcome was the programme of financialsupport from the European institutions and the International Monetary Fund announced inthe Memorandum of Understanding released on December 1st, 2010 (Department ofFinance, 2010). The projected financing needs of the state have thus been assured for theshort term, but re-entry to the markets for both banks and government is the ultimateobjective. This will require deficit reduction by the state and balance sheet managementmeasures designed to ensure that the states debt level is contained. The deficit adds todebt, and a sustainable exit debt position requires that the deficit be reduced from current

unsustainable levels. But the debt can also be contained to the degree that state assets canbe realised and the proceeds deployed in debt reduction.

The states balance sheet includes financial and non-financial assets. The realisation ofvalue from non-financial assets belonging to the state would also help to de-leverage,shrinking the balance sheet and reducing the requirement for additional borrowing. De-leveraging of this type is a rational component in a strategy designed to address a situationof balance sheet stress. If assets can be realised at acceptable valuations, the proceedsreduce the gross debt (but not the ongoing deficit). In this context, the Memorandum ofEconomic and Financial Policies, agreed as part of the EU/IMF programme, states (pg. 31):

Building on the forthcoming report of the Review Group on State Assets and Liabilities the Government will undertake an independent assessment of theelectricity and gas sectors with a view to enhancing their efficiency. Stateauthorities will consult with the Commission Services on the results of thisassessment with a view to setting appropriate targets for the possible privatisationof state-owned assets.

The Review Groups consideration of the structure and regulation of the electricity and gasindustries, as well as the Groups recommendations on asset disposal in these sectors, willbe found in Sections 6, 7 and 8 below.

2.5 Valuations and the Timing of Disposals

Notwithstanding the stressed condition of the states balance sheet, the states withdrawalfor the time being from international credit markets and the potential reliance, over the nextseveral years, on official external financial support, the Group does not favour a front-loaded programme of state asset disposal for a number of reasons. The availability of thisexternal support from the EU institutions and the IMF means that fire sales need not becontemplated in the period immediately ahead. Moreover, there are complex issues ofmarket design and of regulatory reform in several of the sectors in which the state-ownedcompanies operate, which we consider below. Finally, asset markets, including in particularmarkets for infrastructure-type assets, have experienced weakness due to the more limited

availability of acquisition finance since the onset of the international credit crisis in the


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second half of 2008. Accordingly, there is a risk of depressed valuations being achievedshould disposals be undertaken in a rush in the very short term. It is realistic, however, tonote that transactions have been taking place, and at what appear to be reasonablevaluations, in several markets and that acquisition finance continues to be available, if more

selectively than was the case during the worldwide credit bubble.

In assessing asset valuations likely to be achievable over the next few years, it is desirableto make allowance for the extent of the asset price bubble which manifested itselfinternationally during the easy credit period which ended in 2008. Those who bought assetsduring the peak years of the bubble have in most cases lived to regret it, and the pricesachieved by sellers during those years should be envied. Whenever a price becomesavailable for a particular asset which is well below what might have been available in 2006or 2007, it does not follow that the price is unreasonable or bad value. A more plausibleconclusion is that the prices of 2006 and 2007 were bubble prices and unlikely to berealistically available in future years. This point needs to be borne in mind when assessing

prospective valuations for assets which might be included in any disposal programme.

2.6 Microeconomic Policy and Asset Disposals

Where the state owns financial assets or small stakes in competitive businesses, thedecision to dispose and de-leverage the national balance sheet is straightforward to thedegree that the decision does not have implications for other aspects of economic policy. Adecision to realise some or all of the value of a portfolio of shares held in the NationalPension Reserve Fund, or of non-controlling stakes in other businesses, or of surplus realestate, would all fall into this category. Disposal is essentially a financial decision andleverage reduction is attractive if reasonable prices can be achieved, particularly given the

considerable increase in state funding costs.

The situation is more complex in the case of many of the state-owned companies. Thesecompanies control and operate important infrastructure networks that are monopolies or areotherwise engaged in activities where the relinquishment of state ownership raises issues ofmicroeconomic policy. Those companies deemed to be natural monopolies or to possesssubstantial market power are subject to economic regulation and there are EU directives tobe complied with concerning state policy towards the sectors of the economy in which theyoperate. Some of the companies, for example in public transport, are explicit instruments ofpublic policy as well as seeking to be commercial organisations. Some assets may be seenas intrinsically strategic and retention in public ownership may be viewed as vital for

economic development. But other public policy instruments are available to government toachieve public interest objectives that do not require continued state ownership in all cases.

Disposal of these companies or of portions of their activities to private sector purchasersrequires consideration of microeconomic policy issues in addition to financial questionsabout disposal proceeds or timing. These include the structure of the market that is desired,the impact that a change of ownership might have on conditions of competition, theadequacy of existing regulatory arrangements for the changed environment and theimplications of the loss by the state of direct control through ownership. There may be acost to the state in correctly addressing these issues a monopoly inadequately regulated,for example, could realise a superior price to one privatised under stronger regulatory

arrangements. But such a revenue-maximisation strategy could be seen as capitalising in


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the disposal price the buyers expectation of subsequent higher prices, and it would amountto the realisation by the state of the proceeds of a future unlegislated indirect tax. Thiswould of course impose costs on the traded sector of the economy, both directly throughhigher charges to business and indirectly through adding to the price level and hence to

nominal wage expectations. It is in the long-run interest of restoring Exchequer balance toensure that costs to the traded sector are contained, since this will encourage recovery ineconomic activity, in employment and, ultimately, in government revenue.

Recommendation 1: The Review Group recommends that any programme of assetdisposal should be assessed from the standpoint of its contribution to long-term economicrecovery. The Group cautions against any actions which enhance short-term asset disposalprices at the cost of damage to the economys long-run competitiveness, includingspecifically any failures to maximise the potential for competition or any value-enhancement of privatised entities through weak regulatory arrangements.

2.7 Recent History of Disposals of Semi-State Companies

Since 1991, 10 Irish state companies have been sold, starting with the Irish Sugar Company(Greencore) and Irish Life Assurance in 1991 and ending with Aer Lingus in 2006. Inbetween, the Government sold off three state banks (ICC, TSB and ACC); Irish Steel; theferry company B&I Line; the Irish National Petroleum Company (the assets of thecompany); and Telecom ireann (eircom). The sales occurred as opportunities arose andwere sporadic rather than scheduled. Details of these disposals are contained in the tablebelow:

Table 2.2: History of Privatisations of State Companies

Company Year and Type of Disposal ExchequerProceeds

mGreencore 1991 IPO, final placements in

1992/93210

Irish Life 1991 IPO, final placements in1992, 1993 and 1995

600

B&I Ferries 1992 Trade Sale 10Irish Steel 1994 Trade Sale 0eircom 1996-9-Trade Sale and IPO 6,300ICC Bank 2001 - Trade Sale 320TSB Bank 2001 - Trade Sale 410INPC 2001 Trade Sale 20ACC Bank 2001 Trade Sale 155Aer Lingus 2006 - IPO 241

Total for 1991 -2010 8,266

These disposals were successful in raising cash for the Exchequer. In some cases, notably

that of Aer Lingus, the sale enabled the companies to raise funds that the Exchequer was


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precluded from, or not inclined to, provide. The sales were largely uncontroversial exceptin the case of the telecoms firm Telecom ireann.

2.8 Sale of Telecom ireann/eircom

The states disposal of Telecom ireann, which became eircom, remains the largestprivatisation undertaken in Ireland to date. From a revenue-raising perspective it was verysuccessful, raising approximately 6.3 billion of the approximately 8.3 billion raised intotal for all privatisations. It also stands out as an example of the public policy challengesthat arise when the state divests control of a utility with a significant role in a major sectorof the economy.

It has been argued that in selling eircom the government ceded control of an importantinstrument by which it could have directly influenced investment in telecom infrastructure andbroadband roll-out. Total capital investment in telecommunications technology fell from 500

million in 2002 to 209 million in 2005. The state had to invest substantial sums itself intelecoms infrastructure with mixed results.2 Broadband roll-out was below par to the detrimentof the economy, it is claimed. Recent research suggests, however, that this latter claim isoverstated. In the United States, where internet coverage has varied geographically, there is noclear evidence that rural areas with high-quality provision do systematically better than areaswhich attracted lower levels of provision (Forman, Goldfarb and Greenstein (2011)).

The experience in other EU countries had shown a strong correlation between broadbandtake-up and adoption of Local Loop Unbundling (LLU) and/or cross-platform competitionfrom cable operators. Much earlier LLU in Ireland would have enabled other operators tooffer innovative new products and potentially make their products available in locations not

served by eircom. This was an important factor distinct from the state/private ownershipissue. EU regulation had mandated LLU be adopted by all member states by 2001. Eircomwas, however, only nominally compliant in practice LLU was too expensive and tooadministratively complex to interest other operators. Again, ComRegs ability to facilitateLLU was limited in part by legal and statutory deficiencies. In any case, the regulatoryproblems in respect of broadband appear to have now been overtaken in part bytechnological advances: eircoms network has been bypassed in many areas by cable andmobile operators.

Although it is generally accepted that there was a period in which infrastructure andavailability of broadband was below what was desirable, the extent to which this resulted

from control of eircom switching to the private sector is open to debate. The majority ofthose states that currently out-rank Ireland in international comparative exercises onbroadband penetration and speed also privatised their incumbents in the telecoms market, insome cases earlier than Ireland did, and these private entities delivered the necessaryinfrastructure investment.

2 The States interventions consisted of the Metropolitan Area Networks (MANs), State-owned, open accesstelecommunications networks installed in certain towns and cities on the assumption of market failure in theseareas, and later the National Broadband Scheme (NBS), a Government subsidised initiative to provide abroadband service to people living and working in areas where private sector service providers have not

deployed infrastructure on a commercial basis.


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The issue of regulation must, nevertheless, be at the forefront of decision-making on thesale of key assets so as to ensure that, inter alia, any immediate financial gains to theExchequer are not undone by medium to long-term underinvestment in importantinfrastructure. The regulator must have the competence and enforcement powers necessary

to intervene effectively in the event of market failure, in particular to ensure it has thecapacity to impose penalties for non-compliance and has strong competition powers.

2.9 Resolution or Step-in Rights

Companies which are natural or de facto monopolies operating critical infrastructurescannot be allowed to fail and, as the example of Railtrack in the United Kingdomdemonstrates, this problem can be troublesome when the company in question is in privateownership. Statutory regulation may need to be reinforced with powers for the state tointervene and replace private sector management. In their submission the Economic andSocial Research Institute put the issue in the following fashion:

One difficulty is that the regulated firm may take on excessive leverage and use itsinability to raise additional funds for vital infrastructure investment to argue that itshould receive lenient regulatory treatment. Similarly, the firm might undertakerisky diversification, end up in financial or other difficulties and request a priceincrease to fund such errors. Since many regulated firms with market power provideimportant services essential to the everyday functioning of the economy, if these firms were to be become bankrupt or unexpectedly stop supplying services evenfor a short time - then this could have substantial adverse effects on the economy.Thus the regulated firm is in a strong bargaining position when it asks the regulatorfor a price increase, implicitly threatening bankruptcy and discontinuity of service

if it is not granted. (Gorecki et al, 2010)

In order to level the regulatory playing field when the state-owned firm is privatised, oneoption would be to allow the regulator to step in, run the firm and dispose of the assets asthe regulator saw fit if the regulated entity failed to meet the conditions set out in itslicense. The license might, for example, set out a programme of investment that is expectedas well as the regulatory regime that will be imposed on the regulated entity. If theregulated entity is unable to meet the investment programme because it has incurred toomuch debt then step-in rights might be invoked.

Resolution powers are familiar in the banking industry. The motivation is different

depositors need to be protected and bank runs avoided. In the United States, the federalauthorities can remove board and management in a failing commercial bank and keep itfunctioning while arriving at arrangements with creditors. The absence of such powers inthe case of the Wall Street investment banks (since rectified) has been identified by somecommentators as a complicating factor in dealing with the financial crisis in 2008. SomeEuropean countries, including the United Kingdom, have introduced new bank resolutionpowers and in Ireland resolution powers are available in the Insurance Acts and were usedby the Financial Regulator in the case of the Quinn Insurance group. Resolution powers forbanks are also being introduced in Ireland and elsewhere in Europe.


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The United Kingdom governments provisions for a special administration process whichpermits the government to take charge of certain categories of failing privatised firms aredescribed in Box 2.1.

Box 2.1The Special Administration Process in the United Kingdom

An explicit special administration process relating to privatised, regulated industries is inplace in the United Kingdom, where provisions are enshrined in statute to protect water, railand energy network assets:

Measures to protect continuity of service in the water, rail and energy sectors were taken in the WaterIndustry Act 1991, the Railways Act 1993 and the Energy Act 2004 respectively. These contain provisionsthat allow the Secretary of State (or the regulator with the permission of the Secretary of State) to apply to the

High Court to appoint a Special Administrator. The High Court will only make such an order if certainconditions are satisfied, including that the company is (or is likely to be) unable to pay its debts. Othercircumstances that might lead to the appointment of a Special Administrator in the water sector includebreach or potential breach by a company of its duties. The objectives of Special Administrators includesecuring that the licence holder continues to develop an efficient and economical network (or in the case ofthe water industry to maintain supplies) and that the company is either rescued as a going concern or that itsactivities are transferred to another company as a going concern.

The water industry rules have been updated recently:

The new Water Industry (Special Administration) Rules 2009 will come into force on 1st November 2009.The purpose of the Rules is to provide the detail of the court procedure which should apply in relation to thespecial insolvency regime applicable to water companies subject to a special administration order under the

Water Industry Act 1991. Special administration exists to help ensure that water and sewerage servicescontinue to be provided to customers should a water company become insolvent or otherwise be in breach ofits statutory obligations, pending the transfer of the water companys business to another company (or morethan one company).

Therefore, the Rules will be applicable to water undertakers; sewage undertakers and licensed water suppliersthat hold a combined licence and own a strategic water supply (i.e. a supply provided by a licensee that wouldimpact on an undertakers ability to supply its customers if it was withdrawn).

The special administration regime is there to serve the customers interests first, in the event that any of thecompanies within the water industry experience financial difficulties. Customers are protected from theotherwise inconvenient outcome of normal insolvency proceedings for water companies, where the assets andinfrastructure of the company could simply be closed down or sold off to save costs or pay off debts, meaning

that water and sewerage customers would be cut-off from services. However the new insolvency regimeensures the enforcement of water and sewerage services even whilst the company is being transferred to anew owner (or owners).

Recommendation2: The Review Group recommends that any privatisation legislationinvolving companies operating critical infrastructures in Ireland should include explicitprovision for resolution or step-in powers. The United Kingdom rules provide a possibletemplate.


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Section3:MarketDesignandRegulatoryReform

3.1Monopolies and Market Power

Companies can come to enjoy monopoly power in a variety of ways. Some companieswhich are the sole operator in a market are deemed to be natural monopolies because thenature of the industry (e.g. economies of scale) precludes the likelihood of other entrants. Inthese cases the emergence of competing companies is improbable in the absence of somemajor technological change and the companies, regardless of ownership, are felt to requireeconomic regulation in order to protect consumers from exploitation through excess cost,excess profit or both.

These risks are also present where companies just happen to be the only operators in amarket, even though they may not meet the technical definition of a natural monopoly.These companies are de facto monopolies, unlikely to face the threat of competitive entryand are commonly subjected to economic regulation also. Finally, there are statutorymonopolies, that is, companies which have had the exclusive right to operate in a particularmarket conferred by political decision.

Yet other companies operate in markets which are oligopolistic and where there are only afew participants each of which enjoys some degree of market power. Aside from removingbarriers to entry, there is a less clear-cut case for policy intervention in these marketsalthough regulatory intervention is sometimes attempted. Competition authorities in somecountries seek to prevent the emergence of market power through the policing of mergersand acquisitions and the removal, where possible, of entry barriers.

Economic regulation is complex and countries which have been operating economicregulation regimes over very long periods frequently engage in regulatory reform ascircumstances change or as flaws in the system are uncovered. Some writers on theeconomics of regulation have characterised the policy choices in terms of imperfectregulation versus imperfect competition. Thus Joskow (2006):

Regulation is itself imperfect and can lead to costly and unanticipated firm responses tothe incentives created by regulatory rules and procedures. The costs of regulation mayexceed the costs of unregulated natural monopoly or significantly reduce the net socialbenefits of regulation. These considerations lead to a very important policy-relevantquestion. Are imperfect unregulated markets better or worse than imperfectly regulated

markets in practice?

The same writer considers the long history of economic regulation, including theimperative of constant attention to regulatory reform and revision, in a recent paper Joskow(2010).


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3.2Regulating Natural Monopolies

A natural monopoly arises where the nature of the cost curve facing the firm is such that,over the relevant range of output, one firm can always produce at lower cost than two or

more firms.3 An example would be the electricity transmission network: a second,competing network, or a third, would result in overall social costs higher than can beachieved with just one network. A corollary is that new entrants are more or less certain tolose money: no investor will volunteer to build a second network, so natural monopolies donot need statutory protection from entrants. Natural monopolies are not common: mostbusiness sectors are actually or potentially competitive but when they do arise it tends to bein large industries where poor performance by the monopoly would have significantadverse consequences. Poor performance can take two principal forms.

The first is excess profit through exploitation of the absence of competition to extract highprices from consumers. The second is through failure to attain the lowest available costs,

again due to the absence of competitive pressure. This cost inefficiency can arise throughmanagerial lethargy, absence of innovation or through the imposition of rent-extractingactivities by upstream suppliers, including labour unions or monopoly suppliers of rawmaterials. Where the natural monopoly is owned by the state rather than by private capitalthere can be additional cost impositions. The monopoly may have non-commercialobligations imposed by political decision with the costs passed through to customers whocannot resort to an alternative supplier.

For all of these reasons, natural monopolies are often subjected to economic regulation bythe state, and this includes monopolies owned by the state. Regulators face acute problemsin attaining the dual objectives of ensuring that the regulated entity operates on the lowest

available cost curve and also earns no more than the normal rate of profit, see Laffont andTirole (1993). Independent statutory regulation of certain natural monopolies, for examplein the energy networks businesses, is required of EU member states under a series ofdirectives designed to liberalise energy markets and to ensure rights of access to newentrants.

The effective economic regulation of natural monopolies is a great challenge and regulatoryregimes require constant updating, both to reflect practical experience and the inevitabilityof technological change in many of the industries concerned. A particular dilemma is thelikelihood of information deficiencies available to the regulator. This can result in aninability to ensure minimum cost while also controlling rent-extraction. There is a further

trade-off between providing as much certainty as possible to encourage longer-termcommitment of capital by private investors while standing ready to modify regulatoryregimes which exhibit weaknesses.

3 Sometimes loosely described in terms of economies of scale, see Joskow (2006). Strictly, scale economiesare sufficient but not necessary for natural monopoly to occur.


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3.3Economic Regulation in Ireland

There has been a pattern in Ireland of establishing sector regulators for the variousindustries as they were liberalised. Thus there are distinct economic regulators, established

by statute, for energy (electricity and gas), telecommunications, broadcasting, aviation,public transport, taxis and health insurance.

The Department of the Taoiseach commissioned a review of agencies involved in economicregulation from the Economist Intelligence Unit whose remit included the FinancialRegulator and the Health and Safety Authority in addition to the sector regulatorsconsidered here. The report (Economist Intelligence Unit, 2009) draws attention toweaknesses in current Irish arrangements and makes numerous suggestions for changewhich the Review Group has taken into account.

3.4 Discussion and Recommendations

Natural and other monopolies which are regulated have the potential to impose costs on thehousehold and business sectors which add to competitiveness weaknesses in the rest of theeconomy.

Recommendation3: The Review Group recommends that the objectives of economicregulatory agencies need to incorporate, explicitly and on a common basis, theminimisation of cost to the rest of the economy.

More generally, the structure of economic regulation needs constant revision and theprospect of further disposal, in whole or in part, of the states direct ownership in certainsectors requires that adequate regulatory arrangements be in place in advance of ownershipchanges.

Recommendation4: The Review Group recommends that a comprehensive review of thelegislation governing economic regulatory agencies be undertaken and that necessarylegislative amendments be enacted prior to any state disposals.

This review should take account of the specific changes recommended throughout thisreport. It should also consider the ring-fencing of regulated businesses within groups whichalso operate unregulated businesses in competition with other companies. This ring-fencingis necessary in order to avoid cross-subsidisation from the regulated business or therecovery of excess group-level costs, such as finance costs, from the captive customers ofthe regulated monopoly.

In order to underline the essential mission of economic regulators, which is the protectionof consumers from monopolies public or private, and their independence from politics andpolicy execution, it is desirable that the reporting relationships of regulators be re-

structured. The central government department responsible for the promotion of


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competitiveness and for consumer protection is the Department of Enterprise, Trade andInnovation. This is the appropriate unit to which economic regulators should report.

Recommendation5: The Review Group recommends that the Department of Enterprise,Trade and Innovation, which already has responsibility for competition policy, shouldbecome the parent department for all economic regulatory bodies, and should takeresponsibility for their supervision and performance measurement and for legislativeupdating.

The Irish regulatory bodies are financed in large part through fees charged to the sectorsthey regulate, and their staffing and costs are analysed at length, and at times critically, inthe aforementioned Economist Intelligence Unit report. This model of regulator financing isweak, and indeed resembles the type of cost-plus pricing by monopolies which regulation isdesigned to inhibit. It may also be the case that direct reliance on the regulated entities forrevenue increases the risks of regulatory capture, which is a material concern, given theinformation asymmetries that abound. An alternative mechanism that breaks this directfinancial reliance is desirable.

Recommendation6: The Review Group recommends that levies on regulated entities,including license fees and other miscellaneous charges, should accrue directly to theExchequer, and that to strengthen their independent role the operating budgets of economicregulatory bodies should be a charge on the Central Fund.

The Group believes that the implementation of these two recommendations would clarifygreatly the role and function of sector regulators; would provide the opportunity for areview of regulatory design; would permit centralisation of expertise in regulatorysupervision, and would help to address the question quis custodiet ipsos custodes?

The Economist Intelligence Unit report draws attention to the reliance of parentdepartments on regulatory agencies in the process of policy formulation. While consultationwith regulatory agencies and other players is unobjectionable, technical and policy-analyticcapacity should be located principally in the central government departments, without

excessive resort to inputs from agencies whose principal mission is economic regulation.Sporadic deployment of specialist consultants is also unobjectionable, but this should notsubstitute for permanent in-house capability.

Recommendation 7: The Review Group recommends that central governmentdepartments responsible for policy in areas such as energy and transport should ensureadequate internal resources for the task and should avoid excessive reliance on regulatoryagencies and outside consultants.


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Some of the Irish economic regulatory bodies have acquired, or have been delegated,functions which might better be accommodated in executive agencies or indeed in centralgovernment departments. An example would be the Commission for Aviation Regulationsrole in licensing and supervising tour operators.

Recommendation8: The Review Grouprecommends thateconomic regulators should berelieved of responsibility for extraneous administrative functions.

Economic regulation is costly and a wide range of technical skills is required. There havefrom time to time been suggestions that Ireland might be better off with a single super-regulator. The Group has concluded that this course does not recommend itself, but that asmaller number of regulators would be preferable to the existing arrangement. There aredistinct regulators for the telecommunications industry (ComReg, also responsible forpostal services) and for broadcasting (the Broadcasting Authority of Ireland). Thesetechnologies are merging and in some respects are already indistinguishable.

Recommendation9: The Review Group recommends that there be a single regulator forthe broadcasting and telecommunications (including postal) industries.

In its report of July 2009, the Review Group on Public Service Numbers and ExpenditureProgrammes recommended that the Health Insurance Authority be absorbed by the

Financial Regulator, who deals with all other insurance regulatory matters. The VHIs twocompetitors in the health insurance business, Quinn and Aviva, are already subject to theFinancial Regulator.

Recommendation 10: The Review Group recommends that the Health InsuranceAuthority should be absorbed by the Financial Regulator.

The recent establishment of a new regulatory body for public transport provides a furtheropportunity to rationalise. Taxis are a form of (privately operated) public transport and the

Review Group notes that the Taxi Regulators activities have now been absorbed into theregulatory structure of the National Transport Authority.

In 2009, the Special Group on Public Service Numbers and Expenditure recommended thatthe Irish water industry should be comprehensively restructured. The National RecoveryPlan 2011-2014 provides for the introduction of a scheme for metering and charging fordomestic water. A commercialised water industry that might eventually emerge from thisreform would be a natural monopoly and would have to be subject to economic regulation.It has been suggested that the Environmental Protection Agency (EPA), which currentlyhas responsibility for water quality and compliance with EU directives, would be a suitablebody to undertake this task. The Review Group feels that such an aggregation of

responsibilities would not be appropriate and that responsibility for economic regulation in


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the water industry should be assigned to a body distinct from the EPA. In Northern Ireland,a single regulator is responsible for electricity, gas and water. The technical challenges ofregulation in these three sectors coincide to a large degree.

Recommendation11: The Review Group recommends that, in the event that a customer-financed water industry structure emerges, this monopoly should be regulated throughexpanding the role of the Commission for Energy Regulation rather than through theestablishment of yet another sector regulator.

There is a widespread public perception, which may or may not be accurate, thatremuneration levels and employment conditions in Irish state-owned companies aregenerous by comparison with other sectors of the economy, including other areas of thepublic sector, and that this category of state employees has avoided the consequences ofworsening economic conditions nationally. This perception extends beyond the widely-publicised pay packages of chief executives. Economic regulators address all issues ofoperating cost in their determination of allowable price caps under existing arrangements,but the procedures used are not uniform.

Recommendation12: The Review Group recommends that a comparison be made ofpay and conditions in all commercial state companies with those elsewhere in the Irishlabour market and in competitor countries, in particular in the UK, in order to assure thatthe cost structures in these companies are competitive with their counterparts. The outcome

of this review should determine the approach of economic regulators to costs allowable intariff determination.

Monopolies can and do encourage sales through a wide range of marketing activities butthey typically do not feel it necessary to finance large advertising budgets in the massmedia. The Review Group believes that some Irish state monopolies may have over-indulged in mass market advertising which cannot be justified by reference to commercialrequirements.

Recommendation13: The Review Group recommends that sector regulators should seekexplicit justification of mass market advertising budgets from regulated monopolies andshould disallow from cost recovery any element they deem commercially unnecessary.

Where an industry sector such as power generation is privately owned and operated it iscritical that investors are offered as much regulatory certainty as feasible, given the long-lived nature of their investments. Regulatory uncertainty discourages investors and raisesthe cost of capital and hence prices to consumers. This should not however preventnecessary evolution of the regulatory regime.


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Recommendation 14: The Review Group recommends that the legislation governingeconomic regulatory bodies should permit them to grandparent certain regulatoryprovisions for pre-existing operators when regulatory policy changes.


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Section4:TheCommercialStateCompaniesinAggregate

This section discusses the evolution of the aggregate (not consolidated) balance sheet of thecommercial state bodies listed in the Review Groups terms of reference, coveringdevelopments in assets and liabilities including unfunded pension liabilities, capitalexpenditure history, capital expenditure commitments and intentions, industrial strategyincluding acquisitions, dividend history and policy, the structure of debt and credit ratinghistories where relevant. The figures are aggregate and unconsolidated. There would besome contraction of the aggregate balance sheet on consolidation but we believe that itwould be quite minor and that the aggregate balance sheet should be a good guide to theconsolidated balance sheet.

4.1The Aggregate Balance Sheet

The total book value of the states main commercial companies is approximately 8.3billion, based on aggregate shareholder funds as reported in their most recently publishedaccounts. This figure should not be taken as a headline estimate of potential disposalproceeds should all of these companies be sold. The reason is that balance sheet bookvalues reflect accounting conventions and are not a good guide to potential proceeds, whichcould exceed book values in some cases but could also fall short.

Table 4.1: Net Asset Value of Major State Commercial Companies

Notes 2009000

EnergyESB 4,032,150Bord Gis Eireann 1,401,715Bord na Mna (March 2010) 224,408EirGrid 90,332Total Energy 5,748,605

TransportDublin Airport Authority 976,717Irish Aviation Authority 6,299Dublin Port 238,270CIE 1 -Total Transport 1,221,286

CommunicationsAn Post 2 -RT 145,435Total Communications 145,435

Coillte 1,207,484

Total 3 8,322,810Notes 1: CIE has a shareholder deficit of 346.1 million.

2: An Post has a shareholder deficit of 39.8 million.3: No adjustments have been made for any ESOT or off-balance sheet pension liabilities.


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ESB alone accounts for almost half of the aggregate state commercial sector book value,while the energy sector as a whole accounts for almost 70% of aggregate book value.

CIE and An Post have combined shareholder deficits of a little under 400 million,

reflecting sizeable balance sheet pension deficits in each case. Taking these shareholderdeficits into account reduces the aggregate shareholder value of the states commercialcompanies to 7.9 billion. Table 4.2 shows aggregate summarised balance sheets of the topeleven state-owned companies since 2002. The 2009 figures include Bord na Mna data forthe year to March 2010.

Table 4.2: Summary Aggregate Balance Sheet of the Major State CommercialCompanies 2002-2009

YEAR 2009 2008 2007 2006 2005 2004 2003 2002

000 000 000 000 000 000 000 000Summary BalanceSheetProperty, plant &equipment 18,297,089 16,163,245 14,524,835 13,421,841 12,397,566 11,929,291 10,852,512 9,582,716

Intangible assets 509,103 396,535 300,392 422,323 271,500 165,607 35,880 40,637Other (non-cash)assets less currentliabilities 138,820 -568,898 289,727 53,432 200,880 370,898 361,616 536,811

Capital employed 18,945,012 15,990,882 15,114,954 13,897,596 12,869,946 12,465,796 11,250,008 10,160,164

Equity capital &reserves 7,936,856 6,790,417 7,938,559 6,353,409 5,354,304 4,986,606 5,468,445 5,154,288

Minority interests 5,188 12,772 3,908 3,298 3,319 3,418 3,226 3,129Net debt / (cash) 4,667,747 3,300,140 2,686,469 3,220,146 3,363,858 3,927,090 3,239,896 2,699,450

Pension liabilities 1,736,015 1,907,043 744,275 973,294 1,242,311 1,189,567 72,003 ---------Capital grants/deferred income 2,936,368 2,693,300 2,286,559 1,892,212 1,586,490 1,212,026 1,034,051 787,157Other long-termliabilities 1,662,838 1,287,210 1,455,184 1,455,237 1,319,664 1,147,089 1,432,387 1,516,140

Capital employed 18,945,012 15,990,882 15,114,954 13,897,596 12,869,946 12,465,796 11,250,008 10,160,164

A striking feature of the summary aggregate balance sheet is the rapid growth of investment(capital employed) in commercial state companies. Capital spending in 2008-2009 hasaccelerated even in the face of significantly lower levels of economic activity. Between2007 and 2009 capital employed (defined here as total assets, excluding cash, less currentliabilities) increased by 25% from 15.1 billion to 18.9 billion. Much of this investmentwas funded by borrowing, with net debt increasing from 2.7 billion to 4.7 billion over thesame period. This was reflected in an increase in the aggregate debt/equity ratio from 34%to 59%. This increase in indebtedness was of course within individual company borrowinglimits, which in many cases have been increased substantially in recent years. There was afurther substantial increase in borrowing by state companies during 2010: aggregate netdebt of state companies increased by over 40% to just under 7 billion, more than doubleits 2008 level.


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The balance sheet values of capital grants have also risen sharply over the past two years,from 2.3 billion to 2.9 billion. CIE accounts for most of these grants.

4.2Pension Fund Liabilities

Net unfunded pension liabilities of state commercial companies have also shown largeincreases in recent years. The aggregate value of pension deficits, as disclosed in thebalance sheets of the major state commercial companies, totalled 1.7 billion in 2009,compared with 1.9 billion in 2008 and 0.7 billion in 2007. However, these balance sheetfigures significantly understate the size of the actual accounting deficits, shown in Table4.3 below. Accounting rules permit some of the shortfall to be recorded off balance sheet innotes to the accounts. This table also shows that the percentage of pension obligationscovered by pension assets has fallen below 70% in each of the past two years, despite highlevels of pension contributions on the part of most state commercial companies. Thepercentage of total pension liabilities covered by plan assets has ranged over the period

from 84% in 2007 to 62% in 2008, with a partial improvement to 69% in 2009.

Table 4.3: Aggregate Pension Assets & Liabilities

2009 2008 2007 2006 2005 2004 2003 2002

'000 '000 '000 '000 '000 '000 '000 '000

PensionsPresent value of fundedpension obligations 11,057,759 10,917,656 11,466,426 11,999,618 11,183,636 9,641,528 6,535,626 5,767,142

Fair value of plan assets -7,626,965 -6,714,883 -9,687,211 -9,706,658 -8,701,137 -7,247,436 -5,086,317 -4,413,681

Deficit for funded plan 3,430,794 4,202,773 1,779,215 2,292,960 2,482,499 2,394,092 1,449,309 1,353,461Pension assets as % ofobligations 69% 62% 84% 81% 78% 75% 78% 77%

The aggregate pension deficits for 2009 and 2008 as disclosed in the notes to the accountsare, at 3.4 billion and 4.2 billion respectively, approximately twice the balance sheetamounts for these years. The difference is primarily attributable to the accounting treatmentof pensions at ESB, which has opted to defer the unrecognised portion of the pensiondeficit over the future service lives of the employees. As a result, the pension deficit shownon ESBs balance sheet at end 2009 was 0.5 billion (2008: 0.3 billion), compared with anactual accounting deficit for its funded plan of just under 2.2 billion (2008: 2.6 billion).The accounting treatment is entirely within the rules, and is fully explained in notes to theaccounts. ESB has since reached agreement with its workforce on new pensionarrangements which will substantially reduce this shortfall on its pension scheme.

Most state commercial companies provide final salary defined benefit pension schemes totheir employees, although in some cases these schemes are closed to new entrants. Ingeneral, the pension arrangements of state commercial companies look to be more generousthan those provided by private sector companies. Table 4.4 below provides an aggregate ofemployee remuneration packages in the major state commercial companies. The issue isdealt with in further detail in Appendix 1.


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Table 4.4: State Commercial Companies: Aggregate Employee Remuneration

Averagenumber ofemployees

Wages &salaries

Employerpensioncontributions

Average pay(wage/salary)

Employerpensioncontributions

as % of pay

Average payincludingemployer

pensioncontributions

000 000 000 000Dec-09 40,178 2,194,913 344,683 54.6 15.7% 63.2Dec-08 40,589 2,243,730 289,736 55.3 12.9% 62.4Dec-07 40,178 2,138,018 303,271 53.2 14.2% 60.8

4.3Operating Performance

Revenues of state commercial companies have not been immune to the decline in economicactivity over the past two years. Aggregate revenues of the major state commercial

companies, excluding CIE, showed a marginal increase in 2008, up 1.8% to 7.96 billion,before declining by 8% to 7.31 billion in 2009. Table 4.5 below summarises the financialperformance of the state commercial companies since 2002. CIE is not included in thisanalysis as, unlike the other companies, it is heavily reliant on state subventions.

Table 4.5: Operating Summary 2002-2009Year 2009 2008 2007 2006 2005 2004 2003 2002

Income summarystatecompanies(excluding CIE)

000 000 000 000 000 000 000 000

Revenue 7,315,980 7,960,246 7,820,997 6,863,446 5,967,800 5,397,941 5,091,751 4,717,722

EBITDA 1,506,172 1,452,641 1,682,545 1,368,810 1,258,844 1,048,669 1,055,273 865,705Operating profitbefore exceptionals 678,142 744,712 1,024,377 719,543 662,828 531,451 535,850 436,486PBIT beforeexceptionals 733,960 819,534 1,088,594 761,299 715,757 576,193 571,671 481,320

Profit before tax 719,516 637,530 1,353,108 800,683 562,506 436,714 491,029 289,223

Earnings 655,878 553,678 1,201,577 666,559 513,451 370,601 420,946 218,913Earnings before gainon ESB asset disposal 390,874 553,678 1,201,577 666,559 513,451 370,601 420,946 218,913

Dividends paid -336,315 -178,460 -87,318 -85,318 -87,506 -84,142 -37,745 -42,806

Financial Ratios

Operating margin 9.3% 9.4% 13.1% 10.5% 11.1% 9.8% 10.5% 9.3%Revenue/avg. capitalemployed (x) 0.49 0.60 0.62 0.59 0.53 0.51 0.53 ----Avg. return on capitalemployed (before tax) 4.9% 6.2% 8.6% 6.5% 6.4% 5.4% 6.0% ----Avg. return on equity(after tax) 5.1% 7.4% 17.0% 11.4% 9.8% 7.2% 8.2% ----EBITDA interestcover (x) 7.3 8.6 10.7 8.2 7.0 5.6 7.8 8.8

Debt/EBITDA (x) 3.0 2.2 1.6 2.3 2.6 3.6 3.0 2.9

Debt/equity 55% 46% 33% 49% 60% 75% 60% 50%


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The overall profitability of state commercial companies has deteriorated sharply since2007, reflecting weakening margins and lower levels of asset turnover. Operating profitsbefore exceptional items have fallen by almost a third over the past two years. Pre-taxprofits do not serve as an appropriate yardstick of performance as they can be distorted by

sizeable once-off items such as the 265 million windfall earned by ESB in 2009 on thedisposal of generation assets. The same applies to earnings. Because of the relativesignificance of this exceptional gain, 2009 earnings of the state commercial companieshave been adjusted in the above analysis from 655 million to 390 million.

The 2009 levels of operating profits and PBIT before exceptionals are broadly back to 2005levels. Earnings (adjusted for ESBs profit on disposal of generation assets) are below 2003levels. However, reflecting continued high levels of capital spending, returns on investmentin 2009 were by some way the lowest over the period under review. Average return oncapital employed, based on PBIT before exceptional items, fell to just 4.9% in 2009, from6.2% in 2008 and 8.6% in 2007. These returns include the share of profits from joint

ventures and associates. Average return on equity in 2009 was also down sharply from7.4% to 5.1%. Return on equity in 2006 and 2007 included sizeable once-off gains ondisposals.

EBITDA-based debt ratios showed a marked deterioration in the two years to end-2009,reflecting a 10.5% decline in EBITDA since 2007 and an increase in net debt levels of over70%. Net debt/EBITDA almost doubled from 1.6 times in 2007 to 3.0 times in 2009.EBITDA interest cover was down from 10.7 times to 7.3 times. While financial ratios atthese levels are not, of themselves, a cause for alarm (they were weaker still in 2004-2005,for instance) they are of some concern in the context of sluggish economic growth,continuing high levels of planned capital investment and nervous capital markets.

Other things equal, higher levels of indebtedness, together with sizeable pension deficits,serve to reduce the attractiveness of commercial companies to prospective investors. It isimportant, whether or not disposal is contemplated, that capital spending be contained andthat pension deficits are addressed. Higher debt levels also reduce the scope for futuredividend payouts by state-owned companies. Dividend payments by state commercialcompanies in 2009 totalled 336 million, compared with 178 million in 2008. However,the 2009 payouts included a special dividend from ESB of 185 million relating to theexceptional profit on the sale of generating assets in that year. Excluding this specialpayout, the total of ordinary dividends paid by state commercial companies during 2009 fellby 15% to 151 million. This represented 27% of the previous years earnings, compared to

15% in 2008 and 13% in 2007. Excluding the special ESB dividend, 2009 dividends wereequivalent to a little under 2% of year-end shareholders funds. By comparison, Europeanenergy utilities, for instance, currently offer a dividend yield of over 5% and the averagedividend payout represents over 60% of earnings, more than double that paid by the Irishstate commercial energy companies during 2009.

4.4The Special Case of CIE

CIE makes substantial losses at the operating level, 370 million in 2009 and 390 millionin 2008, and receives substantial operating payments known as Public Service Obligation(PSO) payments to offset losses on non-commercial public transport services. These PSO

payments amounted to over 300 million in each of the past three years. In addition, CIE


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receives substantial capital grants, which have increased very significantly in recent times.In the three years 2007-2009 capital grants to CIE averaged just over 500 millionannually, 80% up on the average paid over the previous three years.

Over the period of eight years from 2002 to 2009, CIE received over 3 billion in capitalgrants, most of which went on railway capital works.In 2009, Iarnrd ireannaccountedfor 73% of total capital grants paid to CIE and 67% of CIEs total grant funding. Between2002 and 2009, almost 2.3 billion has been spent on railway capital works, without anyreduction in the requirement for operating subsidy.

Table 4.6: Grants to CIE

2009'000

2008'000

2007'000

2006'000

2005'000

2004'000

2003'000

2002'000

CIE 000 000 000 000 000 000 000 000

Operatinggrants 315,960 321,093 320,163 298,681 283,427 267,786 262,476 252,724State & EUcapitalgrants

441,812 596,821 471,185 345,473 311,202 175,298 395,369 283,042

Total grantfunding

757,772 917,914 791,348 644,154 594,629 443,084 657,845 535,766

IarnrdireannOperatinggrants

183,396 193,618 203,490 202,377 193,327 181,977 185,753 174,893

State & EUcapitalgrants

321,756 431,455 283,671 248,829 316,851 133,739 335,473 214,172

Total grantfunding

505,152 625,073 487,161

451,206

510,178

315,716

521,226 389,065

4.5CEO Remuneration

The Government announced, in the Budget on 7 December 2010, reductions in theremuneration packages of CEOs at the Irish state companies. Although a number ofcompanies have scaled back the financial packages paid to their CEOs over the past twoyears, the effect of this has been offset by hikes in remuneration elsewhere, as shown inTable 4.7 below. Indeed, in some cases a reduction in the basic salary has been more than

compensated by an increase in other elements of the overall remuneration package.


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Table 4.7: Chief Executive Remuneration 2007-2009 ()

ESB Dec-09 Dec-08 Dec-07Salary 432,688 458,309 376,879

Pension 70,961 75,163 59,754Other 248,919 120,849 98,365Total 752,568 654,321 534,998Bord Gis Dec-09 Dec-08 Dec-07

Salary 270,000 288,000 213,000Pension (not shown separately)Other 124,000 73,000 248,000Total (excluding pension) 394,000 361,000 461,000EirGrid Sep 2009 Sep 2008 Dec-2007Salary 228,000 216,000 194,000Pension 68,000 68,000 58,000Other 111,000 73,333 73,333

Total 407,000 357,333 325,000Bord na Mna Mar-2010 Mar-2009 Mar-2008Salary 231,000 247,000 289,000Pension 58,000 62,000 39,000Other 103,000 110,000 37,000Total 392,000 419,000 365,000Coillte Dec-09 Dec-08 Dec-07Salary 297,000 297,000 254,000Pension 74,000 74,000 63,000Other 46,000 118,000 92,000Total 417,000 489,000 409,000DAA Dec-09 Dec-08 Dec-07Salary 320,400 347,900 333,000Pension (not shown separately)Other 247,700 290,600 365,000Total 568,100 638,500 698,000IAA Dec-09 Dec-08 Dec-07Salary 232,000 253,000 207,000Pension (not shown separately)Other 92,000 159,000 143,000Total 324,000 412,000 350,000Dublin Port Dec-09 Dec-08 Dec-07Salary 239,000 222,000 214,000Pension (not shown separately)Other 78,000 77,000 76,000

Total 317,000 299,000 290,000RT Dec-09 Dec-08 Dec-07Salary 276,000 298,000 283,000Pension 24,000 24,000 23,000Other 26,000 26,000 135,000Total 326,000 348,000 441,000An Post Dec-09 Dec-08 Dec-07Salary 386,000 379,000 353,000Pension 77,000 75,000 70,000Other 37,000 39,000 100,000Total 500,000 493,000 523,000Aggregate CEO Remuneration 4,397,668 4,471,154 4,396,998

Note: CIE discloses remuneration of Executive Chairman


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It is a matter for the boards of state companies to satisfy themselves in the first instance asto whether these rates of remuneration reflect the duties carried out, the levels necessary inthe market to attract the relevant talent, and the performance of duties and achievement of

key goals. The Group is not in a position to second-guess the boards in making such anevaluation.

4.6Debt Market Activities and Credit Ratings

As can be seen from Table 4.8, three companies (ESB, Bord Gis and DAA) account forthe bulk of major state commercial company borrowing just under 90% of aggregategross borrowings and 100% of aggregate net borrowings.

Table 4.8: Major State Commercial Companies Financial Summary

TotalDebt PrivatePlacementNotes

Bonds Cash Net Debt/(Cash) Net DebttoEBITDA

m m m m mESB Dec-09 2,230.7 1,036.1 0 2,230.7 2.7Bord Gis Dec-09 2,356.8 730.2 550.0 546.2 1,810.6 5.7DAA Dec-09 1,254.2 850.0 638.2 616.0 4.9Coillte Dec-09 178.9 1.5 177.4 3.2CIE Dec-09 119.9 1.5 118.4 N/MBord na Mna Mar-10 263.8 262.7 206.7 57.1 0.9Dublin Port Dec-09 39.7 0.8 38.9 1.2IAA Dec-09 15.0 19.7 (4.7)EirGrid Sep-09 123.9 153.9 (30.0)

RT Dec-09 0.0 58.8 (58.8)An Post Dec-09 2.5 290.1 (287.6)

Total 6,585.4 2,029.0 1,400.0 1,917.4 4,668.0

CIE does not have significant debt but recall that its very large capital programme has beenfinanced by straight grants, in effect free capital which gives rise to zero debt service costs.All three companies (ESB, Bord Gis and DAA) have successfully accessed internationaldebt markets, helped by their relatively large scale and by the fact that they have RegulatedAsset Bases that can be readily leveraged. Markets are especially attracted to state-ownedelectricity and gas networks. Supportive regulatory regimes are normally a given for such

companies and markets take added comfort from the probability of state support in theunlikely event of financial distress. In the past, this has often been built into credit ratingsbut this has changed in the past few months with respect to Irish state companies. Note,however, that borrowings of these state companies do not enjoy explicit state guarantees.

Standard & Poors assigned ESB a BBB+ long-term rating in January 2011, which wasplaced on a negative CreditWatch. Fitch assigned a BBB+ rating with stable outlook.Moodys assigned a Baa1 long-term rating (equivalent to Standard & Poors BBB+ rating),with a negative outlook. These ratings reflect ESBs stand-alone credit profile and did notincorporate any uplift for government ownership, given the recent deterioration in thesovereigns ratings.


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Bord Gis has had credit ratings from Standard & Poors (S&P) and Moodys since 2003,when it raised US$400 million (343 million) in the US private placement market. It tappedthe private placement market again in March 2009, when it raised US$450 million (386million), bringing the value of its total private placement debt to 730 million. In 2009 it

also issued a 550 million Euro Corporate Bond at a fixed coupon of 5.75%.

In December 2010, Moodys downgraded Bord Giss debt by one notch from A2 to Baa1(equivalent to a rating of BBB+ from Standard & Poors), in line with its stand-alone creditrating, on the grounds that the normal sovereign uplift no longer applied following thedecline in the Irish states creditworthiness. Moodys rates the outlook as negative,reflecting the potential consequences for Bord Gis of the decline in the governmentsfinancial strength.

Dublin Airport Authority had notes totalling 850 million in issue at the end of 2009, ofwhich 250 million (issued in 2001 at 6.15%) are due for repayment in 2011. The balance

of 600 million (issued at 6.6% in July 2008) is due in 2018. At end 2009, DAA had cashbalances of 638 million, equivalent to over half of gross debt (1,254 million). In addition,DAA had undrawn borrowing facilities at that time of 560 million, which have nofinancial covenants or ratings triggers. DAA looks to have adequate financial resources tosee it through the next few years notwithstanding note repayments in 2011.

In November 2010, Standard & Poors revised its previous opinion on the likelihood ofextraordinary support for DAA from moderate to low, reflecting the governmentsreduced capacity to provide support to DAA. This led to a reduction in DAAs rating toBBB from BBB+. DAA was also placed on Credit Watch negative, reflecting uncertaintyover future passenger traffic at Dublin Airport in the context of the weak economic

environment in Ireland. In April 2011, the BBB rating was affirmed on foot of improvedperformance and DAA was removed from Credit Watch.

Bord na Mna has also tapped debt markets twice. In 2006, it raised US$150 million(117.5 million), and in 2009 it completed a private placement of US$205 million (146million) senior unsecured notes with average maturities of approximately 8 years. Thesenotes account for the whole of Bord na Mnas debt of 263 million at end March 2010. Asthe company had, at the same time, cash balances of 206 million, net debt at that date wasjust 57 million.

It is possible, and has happened in some countries, for state companies to enjoy credit

ratings superior to those of the sovereign. We understand that listed bonds of some of theIrish state companies have traded recently in secondary markets at yields lower than thecorresponding sovereign bonds. No Irish state company has tapped the bond markets sinceESB raised 275 million in 6.5% 10 year notes under a 3 billion Euro Medium Term NoteProgramme in March 2010.

4.7Corporate Governance and Other Issues

The analysis set out above suggests insufficiently active shareholder involvement in settingperformance targets for commercial state companies. A common thread is the limiteddividend return to the shareholder and investment of capital with inadequate focus on


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securing an acceptable rate of shareholder return. The first criterion that any shareholder incommercial companies will apply is the return on investment in the form of dividends.

4.8 Dividend Policy

One of the main arguments put forward for retaining state ownership is that commercialstate companies provide dividends to the state. The rate of dividend paid by statecompanies is, however, low and reliability is patchy. Some clearly profitable companieshave paid poor dividends for long periods of time.

Table 4.9: Dividends Paid by Certain State Bodies 2002-2009

2009 2008 2007 2006 2005 2004 2003 2002

m m m m m m m m

Bord Gis 39,074 28,372 8,361 9,079 10,093 9,679 9,796 21,735

Bord na Mna 5,257 12,894 8,035 3,850 NIL 67,118 19,704 20,000

ESB 81,867 129,486 66,722 72,389 77,413 NIL NIL NIL

ESB (special

dividend)

185,317 NIL NIL NIL NIL NIL NIL NIL

Coillte NIL 2,600 NIL NIL NIL NIL NIL NIL

Dublin

AirportAuthority

19,400 NIL NIL NIL NIL 6,074 7,245 NIL

Dublin Port

Co. 5,300 5,108 4,200 NIL NIL 1,271 1,000 1,071

TOTAL4 336,215 178,460 87,318 85,318 87,506 84,142 37,745 42,806

The picture has improved somewhat in the recent past with a general guideline of a 30%dividend now in place. This, it seems, has been taken to apply to normal profits asdividends have not been paid in all cases out of windfall gains. The rate of 30% is not anoverly demanding target. The rate paid by public utilities abroad is often much higher.

The state is not merely a shareholder interested solely in a regular cash return. There arelonger term, strategic goals that require that the reserves of state companies be built up, e.g.to fund investment, especially as the state is usually unwilling to subscribe further capitalresources itself. On the other hand, the lack of dividend discipline may have encouragedfirms to over-invest in capital without seeking an adequate rate of return or, in some cases,to plug pension holes at the shareholders expense rather than by seeking more realisticbenefit levels and staff contributions.

4 Includes special dividends and payments to Employee Share Option Schemes.


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Recommendation15: The Review Group regards the regular payment of a reasonabledividend to the shareholder as good practice and a performance regulator. The Grouprecommends that a dividend of at least 30% of profits should be paid each year except inthe most unusual circumstances.

4.9 Shareholder Value

The Group has noted the large and rapid increase in capital investment by commercial statecompanies at a rate faster than the growth rate in revenue and at low rates of return. Thisexpansion has been financed largely by debt entailing in many cases the provision ofcovenants to lenders which penalise or prevent the disposal of assets by the company, or achange in its ownership, or which constrain dividend payments.

This rapid expansion of capital and the grant of such covenants reduces shareholder valueand can be prejudicial to the shareholders interest. In the Groups view, the governmentshould set and monitor financial ratios to be achieved by companies on an ongoing basis,including the granting of covenants to lenders. These comments raise the issue moregenerally of governmental oversight of state companies activities. The Review Groupbelieves that a better outcome could be assured and a more relevant supervision ofperformance could be ensured if the following arrangements were followed.

The parent departments of Irish semi-state companies, such as the Department of Transportand the Department of Communications, Energy and Natural resources, are responsible fora range of tasks that includes:

- the formulation and execution of policy;- oversight and supervision of the regulatory process, including changes to legislation;- participation in the shareholder function with the Department of Finance.

The joint exercise of regulatory oversight, company ownership and policy formulation andexecution creates the potential for conflicts with the shareholder function. Irish statecompanies, bearing in mind that many of their activities compete with private sectorcompanies and that the government has a disposal option in all cases, need the shareholderfunction to be exercised independently of policy execution. State-owned commercialcompanies should be subject to the prevailing policy framework on the same basis as otheractors, but there is the potential for excess cost imposition where they are also directinstruments of policy. Accordingly, the exercise of the shareholder function needs to beseparated from the functions of policy formulation and execution.

The shareholder function should be more clearly allocated to the Minister for Finance. Thiswould involve, in particular, earlier consultation on major acquisitions or capital investmentand an annual discussion of likely dividends and dividend policy.


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In addition, policy issues in relation to state enterprise generally and the sale or retention ofsuch enterprises in state ownership should be made the primary responsibility of theMinister for Finance. A dedicated policy unit should also be established in the Departmentof Finance to deal with a possible programme of state asset sales whether shares, property

or intangibles.

Recommendation 16: The Review Group recommends that the exercise of theshareholder function in all state commercial companies should be centralised in aspecialised unit located in the Department of Finance. This unit should also takeresponsibility for whatever asset disposal programme is decided on by government.


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Section5:StateEnergyCompaniesandthePolicyFramework

The Review Group believes that alternative ownership options for state energy companiesneed to be considered in the context of energy policy and with due regard to the adequacyof the regulatory regime. If there are weaknesses in policy or in regulation, anyprivatisation of state assets is attended by additional risks to the public interest. In a recentreport, the Irish Academy of Engineering (2011) has stressed the key role of the energyindustry in restoring competitiveness:

In industry efficiency terms the Irish electricity sector does not match the performance of its EU peers when pre-tax price comparisons are used as aneconomic metric. There is an opportunity to lower costs/prices further over the nextfive to ten years by:

-Minimising capital expenditure in the sector.

-Taking advantage of increased supplies of low priced internationally tradednatural gas.

5.1The States Involvement in Energy

In both electricity and gas, the state is a major player in Irelands energy industry. TheElectricity Supply Board (ESB) (Section 6) remains the largest undertaking in stateownership by some margin, accounting for roughly one-half of the state commercial sectorwhen measured by net assets. Moreover, the electricity industry is a critical economic

sector, and its structure and performance have economy-wide consequences.

The state presence in the energy sector also includes Bord Gis ireann (BG) (Section 8),a smaller company than ESB but substantial nonetheless. BG was principally a gastransmission, distribution and supply business, but it has expanded into renewable (wind)and gas-fired power generation as well as electricity supply. The state also owns Bord naMna (Section 10), which is involved in peat production and power generation includingwind, and Coillte (Section 11), which sells forest product into the power generationindustry and has begun to develop interests in wind farms.

Thus, more by accident than design, the state owns three companies (ESB, BG and Bord

Report of the Review Group on State Assets and Liabilities

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